• A central component in the contract established between rating agencies and firms is the attribution of property rights on the score obtained.•A rating agency may prefer to let its client choose what to do with this score; in certain, non negligible circumstances, the firm may prefer not to reveal its score.•Conversely, a rating agency will find it advantageous to maintain ownership of the rating if it has a monopoly on certification markets.

Some agents are more knowledgeable than others as regards certain markets. Rating agencies, however, are attempting to bridge this gap by varying business models. For example, in 2007, Standard & Poor’s entered the market for corporate governance assessments and proposed a new type of contract comprised of several elements: (1) only the firms— and not investors — would pay to obtain the score, (2) the contract with the company would be kept secret, and (3) the contract would authorize the company to withhold the rating. In the case of certification, the firm’s power to reveal or withhold its rating is one of the specific conditions of ownership. S&P decided to transfer property rights to its customers, allowing them the choice of how to use the information. Notwithstanding, are such procedures optimal on intermediary markets?

THEORY AND VOLUNTARY INFORMATIONSHARING

S&P found that some companies never disclose their scores, thus contradicting the “unravelling process” – a standard economic result which predicts that, on the contrary, under certain conditions (in particular, the possibility of transmitting information to the markets in a credible way and at no extra cost), all firms will reveal private information. What does this entail? Imagine that a seller knows the value of an informational asset, and that the buyer values this asset at 100 or 200. Let’s then imagine that the latter—without any additional information— is prepared to pay 150. If the real value is higher than 150, the seller will willingly reveal it, according to the stated conditions. If the seller, on the other hand, discloses nothing, it means the asset is worth less than 150.Thus, buyers will not be willing to pay 150 – perhaps only 125. The unravelling process is then applied, and all scores will eventually be disclosed—the result of which has serious practical implications. This process, however, does not apply to S&P because certain firms keep the information secret. Yet, once they have been informed of their score, they may distribute the information freely. This differs from the standard result when firms have inaccurately assessed their own corporate governance prior to requesting certification. They are therefore likely to make one of two kinds of mistakes: 1) hiring an intermediary when the firm has a low true value, or 2) not hiring an intermediary even though the firm has high true value. The combination of these two effects is in part responsible for hindering the unravelling process. For this reason, a certain degree of uncertainty regarding a company’s quality is required. In fact, companies that have been given a poor score will conceal it, preferring to feign never having requested it in the first place. The secret nature of the contract is fundamental in this case because it allows for the sidestepping of the unravelling effect. In the opposite scenario, buyers would be able to distinguish between those companies that requested certification and concealed their score and those that never hired the services of an intermediary to begin with.

ATTRIBUTION OF RIGHTS AND MARKET STRUCTURE

All economic decisions are based on the comparison of several potential scenarios. For companies, the decision is simple: either pay for certification or stay outside the ratings market. The strategic aim of the rating agency, therefore, is to ensure that the market perceives an absence of certification as negative. The monopolistic intermediary will then subsidize those companies with poor governance so that they too request certification; the better the governance of the firm, the more likely it will be to seek it. This type of cross-subsidization is impossible in a competitive system: agencies cannot subsidize less successful companies. These companies will instead remain outside of the certification market. Thus, a monopolistic ratings market would be in the interest of greater transparency. The authors demonstrate that in order to enable this cross-subsidization, the monopolist intermediary would benefit from controlling score disclosure and, hence, rights of use. Conversely, as competing agencies are obliged to cut prices for their services, they may find it advantageous to transfer the property rights of the ratings to their customers.

Based on an interview with Eloïc Peyrache and his article “The Ownership of Ratings” (April 2007), co-written with Antoine Faure-Grimaud and Lucia Quesada, published in the Rand Journal of Economics.

FROMTHE LAB TO THE WORKPLACE

• Rating agencies might consider making ownership of property rights a strategic variable in their contracts. Companies that have little awareness of their corporate governance (ex. emerging or very innovative markets) may opt for being able to conceal their rating.
• Also, beyond the purely micro-economic nature of the definition of ‘optimal contract,’ this article may also interest public authorities seeking to regulate markets. Would it be useful for a governmental agency to take measures to encourage competition in the ratings market? Not necessarily, believe the authors, who have demonstrated that, in a monopolistic market, the tendency is to reveal more information about corporate governance.

METHODOLOGY

The authors chose to use a theoretical model to analyze: (1) the conditions under which firms may choose to withhold their scores, (2) the structure of the optimal contract between the rating agency and firms, and (3) the conditions under which rating agencies would be advised to transfer ratings property rights to the firms.